Better Talk and Sharper Pencils

“My thesis is that a significant number of individual investors, especially the affluent, have basically gone underground,” Noonan, managing director of capital market insights at Russell Investments, told PLANADVISER. “It’s difficult for their advisers to spend time with them. You can’t get them to come to events. .You can’t get them to come to the office.”

The advisory consulting firm CEG surveyed advisers in 2001 and again in 2012, asking in both surveys, “Which area is of greater importance to focus on, investment returns, or building a deep client relationship?” In 2001, 86% of advisers surveyed pointed to investment returns, and 14% to the client relationship.

But 11 years later, the numbers had completely flipped. A tremendous majority of advisers (89%) pointed to the importance of a deeper client relationship, and just 10% said investment returns were more important.

How to build that relationship is critical, Noonan said. Ten year ago, the financial services industry was in a rut and it was obvious it had to move from a commission-based to a fee-based model. The dominant way of doing so was by helping investors diversify portfolios, providing managed products that would be good ways for Baby Boomers to accumulate wealth.

Now, Noonan pointed out, “We have come to the moment where enough Boomers have reached that point and are now decumulating. The commission-to-fee [change] did not predict the outcome of reaching that moment.” 

Using a mix of strategies and tools, Noonan has worked on ways to help advisers reach these disengaged investors. He calls one of the first steps “relatively careful and forensic listening to the psychology of the investor.”

Some investors express malaise over the capital markets, Noonan said. Depressed over returns, reports of low growth and high liability, investors are also aware that the traditional ways of addressing these conditions, such as investing in bonds, are failing. Investors are expressing a feeling of “wake me when it’s over,” Noonan said. “People are actually using the news cycle, which is inherently shorter than the market cycle, for investment advice, which it was never intended for. But people are using it that way. Relatively dour news about the capital markets, economic policies and the political stalemate in the U.S. as well as overseas has helped create an environment in which the little guy is going to struggle,” he said.

Furthermore, a number of industry scandals are very much eroding investor confidence, Noonan noted, such as rigging of LIBOR rates. If investors feel their mortgage rates, for example, are unfair because the titans are rigging the game, he said, this investor feeling is a definite factor and something the adviser has to be attuned to. “He has to figure out a way to convey he is not linked to that,” Noonan explained.

Advisers need a more precise conversation with clients about their future spending and consumption needs. “It’s really so simple,” he said. “The reason is the amount of expected surplus is going to be less. Whether because of more taxes or more means-testing or because the capital markets don’t do as well—whatever the reason, it’s clear that expectations of assets are going to be lowered.”

Next, the adviser needs to try to bridge the investor’s distance and create strategies to re-engage with the client. Russell Investments has created an asset model that calculates a funded ratio as well as tools and calculators to give investors a tangible idea of what their assets are, and how they will meet future needs. (See “Russell Touts Asset Liability model for Retirement Income.”)

But at base is the client and adviser meeting: A conversation has to happen. “The adviser needs to say to the client, ‘You need to come in. We need to get our heads together take a closer look. We need to sharpen our pencils.’ “But the conversation takes place in a modern context, Noonan pointed out, using more sophisticated tools that better assess whether someone’s assets are sufficient to fuel the lifestyle they want.

Updating a Portfolio 

The modernization of this talk can come in the form of diversification advice, Noonan said, ensuring that the advice for a portfolio is as fresh as it can possibly be, helping to protect against inflation. Infrastructure as a type of investment with some good characteristics to immunize against inflation is one example of what Noonan calls up-to-the-minute thinking on asset allocation. Revisit the portfolio, looking at emerging markets, re-examining the use of bonds, seeing if you can diversify on the yield curve, he said.

Above all, Noonan is trying to create a toolkit for advisers. “It’s not a conversation about market speculation, but a joint conversation about the assets and whether they are adequate to meet the investor’s future needs,” he said. For example, current interest rates have had a significant impact on the income that can be derived from a portfolio. “If you wanted $100,000 in income without dipping into principle, you’d need a giant amount of money in principle,” Noonan said. The investor’s goal means looking at different asset allocations, and the adviser must figure out if he can make the assets work a little harder. “You don’t want to pay too much and get too little,” he said.

The funded ratio, a concept Russell Investments borrowed from the institutional level to determine funding levels, is the center of the new discussion. Said Noonan, “It’s the one measurement in the present time that answers the biggest question for the investor: ‘Will I have enough money?’"

One main culprit that inspires negative investor thinking, is that investors fear the system—banks or government—is rigged against them, Noonan said. “They worry they are not smart enough to know if investment managers are tricking them. Part of it is a sense of unfairness, and the feeling that investors cannot combat it on their own.”

“The smart adviser steps right in and speaks to that specific concern,” Noonan said. He recommends advisers not try to dispel or dismiss fears, but embrace them: “You know there’s some chance that some of that may be correct. All the more reason we have to get together and assess how much flexibility a client has in future spending. The conversation allows the adviser to create more possibility for clients.”

In general, Noonan said, the affluent are much more flexible in their consumption than they give themselves credit for, and have much more ability than they realize to rein in spending in hostile environments. “If I could tell an adviser to do one thing,” Noonan said, “it would be to appeal to clients in this way. ‘We need to get together, and I need to understand the true parameters. How much flexibility can there be in your plan?’” The adviser needs to pin down the investor’s risk tolerance, planned retirement age, whether there’s any thought about continuing to work past retirement age, and whether spending can be tightened.

Listening to clients plan and being the best listener is crucial, Noonan said, meaning “not ‘hand-holding listening,’ but listening to create the best advice for the client.” The adviser needs to listen to the investor’s concerns about the integrity of market operators and then demonstrate that he is ethically separate from those inactions.

Advisers spent some years learning how to do planning better. They got certifications and adjusted their focus, so they are not so much in sales as they are in service. But now the base of assets is on the decline, Noonan said, and advisers must seeks ways to help their clients make the most of the assets they do have while maintaining a successful practice. In other words, advisers can do well by doing good. “The adviser wants to make sure that his clients are not going to spend themselves into destitution,” he explained. “He can keep them in a state of affluence and in his client book.”

Since you cannot always count on altruism, Noonan said, the key is to create an alignment in the incentives and the interests of both parties. But it can take a long time, like a lot of sensible things, to get people to focus.

You can’t have a conversation with someone who is totally unreceptive to you,” Noonan pointed out. “The magic cartilage is the ‘we-need-to-sharpen-the-pencil’ conversation.” While the use of asset-liability models from the institutional level to the personal investor and other strategies come into play, really, Noonan said, “it’s just a better pencil.”